What Is a Fiat Currency
Fiat (fiduciary) currency refers to money the nominal value of which is established and guaranteed by the state and which the government of the country has declared as legal means of payment. Fiat money does not have intrinsic value and is not secured by reserves.
Fiat Currency Definition
It is a currency whose value is provided by the state that issues it and in whose territory it operates. The value of such money does not depend on the material from which it is made as well as state or bank reserves. Fiat currency exists only at the expense of the authority of the state and the laws that it establishes. The fall in authority greatly reduces the value of such money.
Fiat currency can exist both in cash and in electronic form. Most modern state currencies - US dollars, pounds sterling, euros, yen, etc. are fiat. Cryptocurrencies, for example, bitcoins, are typically not fiat, as they are issued in a decentralized manner and do not depend on states or banks. Their value is provided only by the demand of people. It is possible to trade cryptocurrencies at online trading platforms such as Monfex.com.
Fiat Currency Meaning
The value of paper money is primarily associated with the belief of people that it can be exchanged for something valuable. The decline in the authority of the issuing government leads to a decrease in the purchasing power of fiat money - inflation.
Fiat currency is the opposite of commodity money. Commodity money is valued based on the material used to manufacture it. Fiat money provides more flexible pricing as well as more affordable transportation and release. Fiat currency is very useful in successful countries because its price rises along with the economy of the country and people's confidence in the price of their money.
The term "fiat money" was first used in the resolutions of one of the party congresses held in the USA in the last quarter of the 19th century. In fact, the United States did not have a central bank or a gold standard at that time, and the concept that was discussed fit into the then existing terminology of fiduciary money.
The main mechanisms for ensuring the value of fiat money are:
- the legal obligation to use it when making payments and settlements, restrictions on the circulation of other currencies in the territory of the state;
- use of national currency to pay taxes and fees established by the state;
- assignment of interest rates by the central bank.
Fiat currency meaning, as well as the detailed meanings of other financial terms, can be found in our extensive financial dictionary at Monfex.com.
History of the Fiat Currency Term
In modern times, the term “fiat money” or "fiduciary money" appears in sync with the organization of the circulation of banknotes, which was conducted by the Bank of England. Initially, the banknote was a bill of the bank, which accepted for storage a certain amount in a full gold coin from the depositor. Under such conditions, the amount of money circulating in the economy was equal to the number of gold coins in the bank's vaults.
However, the development of capitalist relations in Great Britain required a greater money supply than was available in the entire economy. In this regard, the Bank of England began to issue banknotes for which there was no equivalent amount of gold. The Bank Charter Act of 1844 set the limits for this uncovered emission as a percentage of the country's gold reserves. The monetary system, which was based on gold as the universal equivalent, was called the gold standard.
With the development of methods for calculating the allowable cash supply, new varieties of the gold standard (gold bullion, gold exchange, etc.) appeared. Anyway, the owners of fiduciary money could present them to the bank in order to receive a full gold equivalent.
The final collapse of the last form of the gold standard, the Bretton Woods system, occurred in 1971–1973. It was when the US government unilaterally refused to issue gold according to the requirements of central banks of other countries. By this time, the composition of the mass, defined as fiat money, had changed. Currently, these include bank tickets and other carriers whose value in circulation is fixed by the amount inscribed on them. The latter is much higher than their intrinsic value (the price of banknote production, etc.), however, the real purchasing power may vary depending on the state of the economy and trust in the issuer (as a rule, this is the country's central bank).
Fiat Money in the History of Monetary Circulation
When outlining the history of money circulation, authors of some textbooks retrospectively summarize the definition of fiat money as all historical forms of inferior money circulation that had existed long before the term was introduced. The first paper money dates back to the 8th century; it appeared in China during the Tang Dynasty. Ramsden mentions fiat money from the time of the Song Empire in China of the 10th century. The Roman emperor Diocletian imposed the death penalty for refusing to accept official coins for payment. R. Michener recalls the bills of credit circulating in the British colonies in America before the declaration of US independence.
Based on the lack of intrinsic value, the listed means of circulation can indeed be formally classified as fiat money. However, the generality of the term applied to them hides fundamental differences between them: fiat currencies are not only “pieces of paper”, but, for example, billon coins, which these authors do not mention. In different cases, issuers provide the equivalent, on which holders of these obligations can theoretically rely. In this regard, credit money is allocated to a separate group, the issue of which is somehow related to the issuer's future income - for example, in the form of taxes, duties, etc.
By the beginning of World War I, most countries were using the currency, which at any time could be converted into gold. Today, most national currencies have no official commodity support. The state obliges citizens to accept banknotes and coins as legal means of payment in their territory.
Now you know what is a fiat currency. In addition to the fiat currency definition, our financial glossary contains over 100 helpful terms related to fiat currencies, cryptocurrencies, and more. Monfex.com is a reliable platform where you can search for financial terms and trade cryptocurrencies.